The resurgence of petro-nationalism

By Rodolfo Guzmán, Santos Cohen and Román Vélez of Arthur D Little

While many countries with modest oil and gas resources are making efforts to attract a larger share of international exploration and production investments.several with large resources are moving in quite the opposite direction.

Recent years have seen interesting changes in the interactions between international oil companies (IOCs), the host governments and national oil companies (NOCs) that own or control hydrocarbon reserves. While many countries with modest oil and gas resources are making efforts to attract a larger share of international exploration and production investments, several of the countries endowed with large petroleum resources are moving in quite the opposite direction. These nationalistic trends in the wealthiest petro-nations can be observed in different regions of the world. They take the form of increased participation of the state in the oil and gas industry, rises in tax and royalty levels, revisions to existing contracts and possible expropriation of assets. At the same time, several NOCs are increasingly engaging in international expansion strategies and competing strongly for scarce investment opportunities around the world.

Over the last five years, several hydrocarbon-rich countries that had previously opened their doors to international investors have shown a desire to expand the role and share of wealth of the state in their oil and gas industries, reducing the share of foreign participants. Some examples in this category include Russia, Venezuela and Bolivia. Other countries like Argentina, which privatized their oil industries during the 1990s, have now decided to recreate their national oil companies. And in countries such as Saudi Arabia, Kuwait and Mexico, which have been toying with the idea of opening their oil industries to foreign investment for some time, the political debate around these issues is intensifying.

These recent trends towards increasing nationalism in the global oil and gas industry represent a departure from the wave of privatizations and openings that prevailed in the sector during the late 1980s and most of the 1990s. The examination of recent events in different regions helps to identify the symptoms and characteristics of these nationalistic trends. The Middle East accounts for over two thirds of global hydrocarbon reserves and therefore has tremendous strategic importance for the IOCs. All major oil companies would like to eventually regain a foothold in this region. However, two of the largest countries in terms of reserves – Saudi Arabia and Kuwait – remain largely closed to foreign investment. In Russia, the state is gradually strengthening its control of the oil and gas sector while avoiding outright nationalization. Meanwhile, in Latin America several countries (particularly Venezuela and Bolivia) have recently moved in the direction of increased state participation in their energy industries.

NOCs go international

While IOCs are facing tougher times getting access to hydrocarbon resources around the world, many NOCs are starting to aggressively deploy international strategies. It is estimated that close to one third of the 120 NOCs in the world have business interests outside of their home country.

There are several reasons why NOCs are competing abroad. The most important is the need of some large and rapidly growing economies, such as China and India, to secure their long-term energy needs with access to international hydrocarbon reserves. Other more entrepreneurial NOCs like Statoil and Petrobras go abroad to take advantage of the technologies or specialized know-how (such as deep-water operations) that they have developed at home. And then there are NOCs, such as Malaysia-based Petronas or PDVSA in Latin America, whose strategies are closely related to political and cultural advantages.

The internationalization of the NOCs creates further challenges for IOCs of different sizes. NOCs do not always respond to normal commercial pressures and are often willing to sacrifice profits in pursuit of their strategic interests. Chinese NOCs, for instance, have made aggressive bids to acquire oil companies and international properties, aided by their access to low-cost capital from their government.

With the proliferation of regional alliances such as the PDVSA-led “PetroAmerica”, NOCs are often regarding other NOCs as the preferred partners for the execution of politically sensitive projects. For example, it has been speculated that if Mexico ever decided to seek help from foreign firms to exploit its potentially huge deep-water reserves, it would be politically more palatable to form a partnership with an experienced NOC such as Petrobras than with any of the major oil companies. The potential threat to sovereign rights is perceived as lower when the counterpart is another state because the energy cooperation can be placed in the context of a larger bilateral relationship between two friendly countries.

Why are nationalistic trends increasing?

The resurgence of petro-nationalism is the consequence of a complex array of economic, technological, political and social developments that include global as well as regional and local dynamics. The specific causes of nationalistic trends and the way in which these trends are manifested can be very different in countries as diverse as Russia and Venezuela. There are, however, a few common factors that help to explain why an increasing number of nations are shifting towards stronger state participation in their oil and gas industries. We will stress here three underlying drivers of these trends: higher energy prices, commoditization of technologies and generalized disenchantment with the deregulation policies of the 1990s.

Higher energy prices

The most important force behind the resurgence of nationalistic trends in the global oil and gas industry is undoubtedly related to the increase in the level of hydrocarbon prices in recent years. As the rent generated by the exploitation of oil and gas resources has increased significantly, it is only natural for nations to aspire to a larger share of this windfall. Several countries have dealt with the fluctuations in oil prices by developing progressive fiscal regimes in which the government’s take automatically increases when commodity prices go up. Others, however, have implemented more radical reforms, including changing their hydrocarbon laws and revising existing contracts to obtain an immediate increase in the government take.

These reactions are usually perceived by foreign investors to be a violation of their contractual rights, and they are sometimes attributed to an entrenchment of nationalistic attitudes and behaviors in the host country. The governments, on the other hand, believe they are only exercising their legitimate rights to appropriate a fair share of the wealth and allow their citizens to benefit from the oil bonanza.

Oil prices are also a determining factor in the level of capital investment of the NOCs. When prices are relatively low, governments tend to extract a higher portion of the NOCs’ cash flows in the form of taxes and dividends to finance much-needed public spending. This can leave the NOC in a precarious financial condition, and hence foreign oil firms are desperately needed to bring the capital required for the development of large investment projects. However, when oil revenues are high, NOCs are allowed to reinvest a good portion of their cash flows, and countries can significantly reduce their dependence on foreign firms in capital investment projects.

Commoditization of technologies

Increasing commoditization of technologies in the global oil and gas industry is also contributing to the spread of petro-nationalism. In the past, ownership of proprietary technologies was a critical differentiating factor for the major oil companies, particularly in the upstream segment. Technological advances led by the oil companies were a major driver of improved performance during the 1980s and 1990s. For instance, breakthroughs in exploration and production techniques allowed oil companies to get access to offshore resources in extra-deep waters, significantly increase oil recovery from existing fields and reduce geological uncertainty with the use of 3D seismic methods.

Despite the tremendous importance of technology in value creation, an overwhelming focus on efficiency improvements during the 1990s led most of the largest oil firms to reduce their levels of research and development expenditure. Significant cost pressures, a wave of mergers and the increasing difficulty of protecting technology leadership gave way to new philosophies about the role of R&D as a competitive tool in the oil and gas industry. As a result, the major oil companies started placing more emphasis on technological collaboration and outsourcing, and the ability to assimilate and deploy new technologies became more important than invention and ownership. At the same time, large service firms such as Schlumberger and Halliburton have been investing heavily in improving their technological capabilities. In this new environment, it is much easier for cash-rich NOCs to get access to critical technologies through such service firms, while further reducing their dependence on foreign oil firms for the execution of technically challenging projects.

Political and social disenchantment

Another factor contributing to the resurgence of petro-nationalism in recent years is the disenchantment with the neo-liberal policies that were enforced in several places with the support of multilateral institutions such as the International Monetary Fund. While these policies contributed to successful economic reforms and vibrant private sectors in several countries, in other places, such as Argentina, Venezuela and Bolivia, the long-term outcomes were not quite as expected. Rushed privatizations, sudden elimination of trade barriers and poorly planned deregulation of markets led in many cases to greater levels of social inequality and popular discontent. As a consequence, new governments with fundamentally different ideologies have been elected in some countries and the banner of nationalism has become popular once again in the political discourse. For instance, Argentina, which privatized its national oil company (YPF) during the early 1990s amidst a wave of market liberalization policies, decided in 2004 to recreate a new national oil company with the name of ENARSA. This recreation of the NOC was in part due to the government’s desire to intervene in the domestic energy markets to prevent situations of abuse arising from the oligopolistic positions of a few private players.

The impact of all these drivers must be seen against the background of a shift in expectations about long-term hydrocarbon availability due to diminishing exploration success and faster-than-expected depletion of the world’s largest oil fields. Tensions around the control of energy resources are producing various self-reinforcing effects including heightened concerns in the most powerful nations regarding their long-term energy security, increasing perception of potential political and military conflict around the major petroleum regions, and stronger manifestation of petro-nationalistic trends around the world. The combination of these elements creates a vicious cycle by putting additional upward pressure on the price of hydrocarbons.

Challenges for the global oil and gas industry

In a world where approximately 80 percent of the total hydrocarbon resources are owned or controlled by states and NOCs, the resurgence of nationalistic trends can have significant consequences on the dynamics and flows of international investments in the oil and gas industry. For instance, securing access to new sources of abundant oil or gas reserves is becoming an ever-increasing challenge for most IOCs. In fact, several oil firms are struggling just to replace the volumes of hydrocarbons they are currently producing, and with few big oil fields left to be discovered, they are being forced to venture into riskier and harsher environments. The balance of power is therefore shifting in favor of NOCs.

IOCs also need to be able to book reserves, or at least share in the profits of their oil developments in order to keep their shareholders happy. However, this is becoming increasingly difficult in places such as Mexico, where emotional arguments about the ownership of hydrocarbons are rooted in historic events and deeply connected to expressions of national sovereignty.

Meanwhile, contractual rights over oil and gas are becoming increasingly vulnerable in various parts of the world. In Venezuela and Bolivia, for example, new hydrocarbon laws can overrule the validity of any contractual condition granted under previous regulatory schemes. This presents a new challenge for IOCs, which now need to reflect the increased level of political and contractual risk in their investment equations.

The implications of petro-nationalistic trends also extend to the arena of foreign policy. In Russia, for instance, the state is using its increasing oil power as a bargaining tool in its relations with the major superpowers of the United States, Europe, China and Japan. Venezuela is also capitalizing on its enormous oil reserves to increase its influence in Latin America and attempt to displace the US as the dominant player in the region’s politics.

Insights for IOCs

In this challenging and unpredictable global environment, it will be critical for IOCs to be able to differentiate themselves with offerings that go beyond the traditional provision of capital and technology.

Invest wisely in local development

Several countries around the world are already demanding high levels of local content for large oil and gas developments. In places where the domestic construction and services industries are still undeveloped, the IOCs need to work out detailed strategies to provide appropriate training as well as technical and financial support to local vendors and contractors. This usually requires a completely different approach to project management, demanding greater managerial attention and effort than the traditional projects where most of the work was contracted out to a reputable international engineering, procurement and construction firm. International players with a long-term business view should consider these strategies as an investment in their own success, as the local workforces they are training will be the enablers of more efficient and productive operations in the future.

Support NOCs with their social objectives

For many NOCs around the world, state ownership means that there is no clear distinction between achieving their business and commercial goals as an enterprise and contributing to the social and policy objectives of their governments. In fact, these apparently contradictory objectives often coexist in the scorecard that is used to measure management performance. While this concept may be anathema to a profit-driven IOC, it is not surprising that many NOCs expect their foreign partners to pitch in towards the achievement of their country’s social goals. Therefore, rather than worrying about the typically marginal impact that a higher level of community investment will have on the rate of return of their projects, IOCs should look for ways to maximize the impact that these investments can have through a closer alignment with the stated social goals of the host governments.
Be open-minded

IOCs need to be open-minded, flexible and sensitive to the needs of different stakeholders in their host countries even when these requirements extend beyond traditional business boundaries. However, IOCs should never give up their right to specify and make transparent the type and amount of resources that they are willing to commit for these purposes. Full transparency will always be beneficial to both parties. The NOC needs to know how well it is performing commercially and how much is being contributed to its communities and other national goals. Such knowledge also provides the IOC with an opportunity to quantify and disclose its specific contributions, strengthening its public image.

Rodolfo Guzmán.is a Director in the Global Energy Practice based in Houston. He has over 15 years of consulting experience in the oil and gas industry and has provided strategic and organizational advice to many leading international and state-owned oil companies around the world. (guzman.r@adlittle.com)

Román Vélez is a Consultant in the Caracas office and a member of the Global Energy Practice. He has over 10 years of experience in the oil and gas industry and has been actively involved in a variety of energy-related projects. (velez.roman@adlittle.com)

Santos Cohen is a Business Analyst in the Caracas office, working on the Energy and TIME practices. Santos has participated in energy-related projects in South America for both private firms and public entities. (cohen.santos@adlittle.com)